Contributor Dr. Tom DePaoli
You receive an edict from upper management: “Every department is to reduce costs by 5 percent.” What approach will you take to help shrink expenditures?
Uncovering a step-by-step formula that allows purchasers to reduce costs systematically is about as easy as understanding Einstein’s theory of relativity. No single method ensures success.
A cost-reduction strategy depends on the specific steps a purchasing department has already undertaken and what information is available. While no single approach works for every organization, commonalities exist that purchasers can apply within their own organizations. Initial, specific steps can be taken by any purchasing department. Then, a number of individual opportunities exist that can help purchasers reduce costs on behalf of their organization’s bottom-line.
Step 1: Target the High-Dollar Expenditures
Generally, the first step in determining where to reduce costs involves reviewing the purchasing history of the organization. “Where you begin depends on how much data purchasing has available,” says Ronn Williamson, principal of Williamson Consulting in Edina, Minnesota. Once all of the organization’s expenditures are categorized, purchasing should prioritize them based on where the most dollars are being spent and identify purchasing’s current involvement – in terms of cost savings – with those high-dollar expenditures, says Williamson. Purchasing usually will find some high-dollar expenditures that are not going through the purchasing system.
Ideally, purchasing should determine which materials, products, and services the company spends the majority of its money on and then target those areas for cost-reduction opportunities. As a result of identifying the dollars spent inside and outside the purchasing system, purchasers can now select one or two high-dollar areas to target for cost reduction. Special note: If purchasers select a high-dollar purchase carried on outside the purchasing department to target with cost-reduction efforts, they will have to act in a supporter/facilitator role since they do not control the purchase. (See the June 1995 issue of NAPM Insights with the theme “Who Spends What?”*)
Often, adds Williamson, opportunities for cost reductions lie in those areas where no purchasing data or history exists. “If they don’t have purchasing records – because a lot of the expenditures may not go through the purchasing system – a way to start is by talking to the controller’s group and looking at financial records,” he says. By talking to accounting and reviewing departmental budgets, purchasing can prioritize alternative cost-reduction possibilities.
Harlan Lorenz, C.P.M., vice president of Lorenz & Associates in Farmington, Michigan lists some of the areas that offer the greatest savings potential: high purchase volume material; high purchase volume with one supplier; materials or services used by more than one location or department; materials with a high inventory level; materials with high freight costs; materials with a high rate of change in requirements; and materials with high set-up costs.
Step 2: Develop a Cost-Cutting Team
Next, purchasing should form a team whose main objective is to identify new cost-reduction opportunities to be found with the help of the purchasing department. By establishing a team of users, individual members will be able to provide input as to areas where cost reductions will be possible. Other departments may have buying procedures with which purchasing is not familiar or not directly involved. By bringing together individuals from other departments, the team can begin to examine and address previously unknown cost-reduction opportunities.
“Usually our cost reduction is done with cross-functional teams, people from other departments. They can look at what really happens and give their input,” confirms Thomas DePaoli, Ph.D., C.P.M., purchasing manager for Will-Pemco, Inc. in Sheboygan, Wisconsin.
Step 3: A Quick Hit
For purchasers who need to realize an immediate reduction in expenditures, examining the purchase price of a product or service may be one place to look. While lowering prices paid may not be considered a true cost reduction, it can promptly address an urgent situation.
“You can’t have the same cost-reduction strategy for every material,” says DePaoli. However, depending upon the urgency of the necessary reduction, the initial purchase price may be the first consideration. Purchasers say if you haven’t checked pricing in a couple of years or you’ve increased the volume that you’re purchasing, sending requests for quotations can reduce costs. You want to make sure it’s still a win/win situation.
But remember, concentrating only on purchase price (often labeled cost avoidance) is only one aspect of a total cost-reduction strategy. In fact, some contend that as professionals, purchasers should naturally be securing best price. Some, therefore, don’t include purchase price (or cost avoidance) in their cost-reduction strategy.
Some Well-Known Opportunities
Supplier Consolidation. Depending on the size of your organization’s supplier base, supplier consolidation is often effective in reducing costs. “With a large supplier base, it’s practically impossible to do any meaningful cost reduction. If you have too many suppliers, you don’t have time to develop relationships that focus on cost-reduction strategies,” says DePaoli.
Choosing the best suppliers is crucial. To do that, DePaoli suggests that purchasing should have a standard, systematic approach for supplier selection which involves research. A relatively simple way of reducing the supplier base is to distribute purchasing expectations to potential or current suppliers outlining your specific requirements, he says. “Once they see it, a lot of them drop out. Then you narrow it down using a systematic approach.”
Brian Schultz’s group at Pacific Bell in San Ramon, California consolidated its supplier base by identifying the product families where the most money was being spent. They then went through bidding scenarios to determine which suppliers could provide the best total cost. “If they could meet our service needs, such as delivery, quality, and customer support, we made our decision based on which supplier could provide the lowest total cost of ownership not just the best first cost,” says Schultz, manager for outside plant contracting.
Supplier Alliances. Strong supplier alliances can allow for continuous, long-term cost savings for purchasing. When Schultz has a cost-reduction challenge, he involves his major suppliers and asks for suggestions. Those suppliers review the costs involved with the product or service and then identify any unnecessary expenditures or processes.
DePaoli finds that 80/20 rule applies. 80 percent of purchasing’s effort is concentrated on 20 percent of the dollars spent. He recommends using your strategic or key suppliers to help you drive out the administrative and transaction costs, while purchasing simply monitors the process. For example, one of DePaoli’s machine-tool supplier’s provided a computer system to Will-Pemco so that the purchasing department could order direct via computer. As a result of supplier support, purchasers can concentrate their major cost-saving efforts where the other 80 percent of the dollars are spent.
“Suppliers have a lot of good ideas on how to save money,” says DePaoli. He also asks his suppliers to do a process-flow chart of his company by plotting out the supply chain. DePaoli does this with his key suppliers. This process ensures that the suppliers understand how the purchasing organization does business. Purchasing also visits the supplier’s organization to understand how they make the materials purchasing uses.
“You want the supplier eventually to be an extension of your own company. This requires a lot of energy and constant communication across all levels of both companies,” says DePaoli.
Challenge Specifications. Within a strategic alliance, one area to target for cost reductions is existing product specifications. Frequently, specifications are never challenged. “Specs are put into a product not because the customer wanted it but because an engineer thought it was better or manufacturing wanted it this way,” says DePaoli. “The challenge of the process is trying to understand what the customer wants.”
Early supplier involvement in design can eliminate the need to challenge product specifications altogether. Williamson says it’s the key to getting cost reduction built into the design criteria.
Miscellaneous. The list of potential cost-reduction opportunities is lengthy. (See “Cost Reduction: Carpe Diem!” on page 6 of this issue.) Some companies have gone as far as relocating part of the operations to a different area of the country where the cost of living is lower and the overhead is less expensive.
To avoid the panic of an immediate, mandated reduction, purchasing should be reviewing processes continually to identify cost-reduction opportunities. In the absence of that, a simple, well-considered approach should work the best.